Dealpolitik: Microsoft’s Brilliant, Legal Tax Dodge

Will Microsoft’s $8.5 billion purchase of Skype be a wake up call for lawmakers on the need for corporate tax reform?

Skype can thank a large part of its big payday on the country’s corporate tax code and being organized outside of the U.S.

Here is the issue: U.S. companies with world-wide operations like Microsoft do not immediately pay U.S. corporate tax on the earnings of their foreign subsidiaries. They pay that tax only when the funds are repatriated into the U.S. Since the corporate tax rate here is 35%, they have to pay a toll of as much as a third to get the money back in the U.S. To avoid this toll, they leave the profits overseas in what is sometimes referred to as “foreign trapped cash.” And trapped cash is exactly what Microsoft is using to buy Skype.

Skype had a huge advantage in being a Luxembourg corporation. If it had been a Delaware corporation run out of Silicon Valley, and Microsoft had used that same $8.5 billion of offshore cash, it would only have been able to pay around $5.5 billion after paying the tax.

Venture capital and private equity players are certain to heed the message: Organize a development stage company in the U.S. and risk leaving big money on the table. This incentive is not news to the private equity players. And it is not just at the exit when a foreign holding company is treated more favorably from a tax perspective.

The big question is: Will Congress let its bickering over corporate tax reform push the next wave of technology companies overseas?

The issue has become an emotional one in Congress. Republicans argue that by taxing repatriation we discourage investment and job growth in this country. Democrats argue that multinationals are shirking their tax responsibilities by parking funds overseas. And there are huge amounts involved, both for the multinationals (remember how GE paid almost no U.S. tax this year?) and the U.S. Treasury.

Without corporate tax reform, the stunning symbiosis of Microsoft’s foreign trapped cash and Skype’s Luxemburg holding company will make tax planning to emulate Skype more imperative as private equity players invest.

And that means the U.S. could well see up and coming growth companies choosing Luxembourg, Ireland or Singapore as their headquarters rather than Silicon Valley unless Congress acts.

No one in Congress will want to be blamed for that. Maybe the Skype deal is the message lawmakers need to fix corporate taxes.

Comments (5 of 7)

It's sad that the financial reporters of the WSJ don't understand that you can't tell how much a company pays in US taxes by looking at its 10-K.

5:45 pm May 11, 2011

Joshua Goldbard (ThePBXGuy) wrote :

@James: You're quite welcome :).

I think the idea about tax laws is sort of misplaced. I was particularly surprised to see that eBay actually recouped almost all of their investment in Skype from this Sale. Talk about coming out on top after being trounced! I thought they would never recoup any investment from that deal.

4:50 pm May 11, 2011

James wrote :

Thanks Joshua, I did not realize that. But it looks like Skype was invented by entrepreneurs in Estonia, not Americans trying to get around tax laws so it seems to me that would make it an even worse example for the point the author is trying to make. Regardless, thanks for the heads up.

4:18 pm May 11, 2011

The Oneinvestor wrote :

I can't believe how much whining is going on about multinational companies (which may have ORIGINATED in USA) keeping foreign earned cash outside US. What is the point in getting money back to US if you have to buy stuff outside anyway? I mean, if you have to run business outside the US also, and pay rent, electricity, salaries, raw materials etc to produce goods or services outside, you do need to keep money wherever it is, rather than getting it taxed unnecessarily. This is just simple reinvestment. The federal legislator salaries need to be cut down, because the level of implicit corruption is not going down anyway. So why pay them more and still let their brother get contracts etc anyway?

4:03 pm May 11, 2011

Joshua Goldbard (ThePBXGuy) wrote :

Hello,

James, you may not be aware of this, but virtually all of Skype's engineering staff are based in Estonia. It is one of their competitive differentiators.

I don't expect this will result in new tax evaluations; I think we would need a larger deal than 8.5 Billion to shake up the tax code.

I cover the enterprise collaborative technologies space on my blog. If you like, you can read about my opinions on this topic here:

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